Era of Commodity Source and Supply Constraints Cause Many to Rethink Recent Paradigms

SCDigest editorial staff

The News: Numerous acquisitions and very long term supply contracts executed during the past year indicate that in the age of tight commodity supplies and rapidly gyrating prices, some companies want more control over the entire supply chain.

The Impact: After being severely out of favor for many years, “vertical integration” is back in – to a degree. Companies aren’t returning to vertical integration completely, but rather in areas where they perceive the greatest supply and pricing risks.

The Story: Experts are noticing that a significant portion of recent merger and acquisition activity is not related primarily to the search for revenue growth or operating cost reduction opportunities (the usual reasons), but have instead been driven by supply chain concerns over the availability and cost of various commodities.

In some respects, this shows signs of a return to the notion of “vertical integration,” where a company directly owned a controlled most of its entire supply capabilities and processes. Vertical integration has gone almost completely out of favor in recent decades, as companies look to shed hard assets, move to a more variable cost model, and focus on core competencies. Yet, these latest moves show that when the fundamentals change dramatically, so too can the conventional wisdom.

With a variety of commodities, including copper, titanium, iron ore, silicon, and many others, in very tight supply, companies are looking at how they can better establish secure availability of these supplies at better prices to ensure their own competitiveness.

The examples are many:

Bridgestone, the world’s second largest tire producer, bought an Indonesian rubber plantation in 2005. The Wall Street Journal quotes a Bridgestone executive as saying that the “company has determined that in the long term, the global appetite for these strategic raw materials will make it more and more difficult to obtain the quality and quantity of materials necessary for the efficient and profitable operation of the business.”

Armored car and bullet-proof vest maker Armor Holdings last month acquired a supplier of super-strength fibers used in the manufacturer of these core products.

Steel giant Mittal is buying up iron ore producers, and announced it will 82% self-sufficient in iron ore by 2010.

In other cases, companies are signing extremely long term agreements to secure supply of constrained commodities – reducing supply risk, but potentially at higher cost or reduced flexibility as market conditions change. Airbus, for example, has recently signed contracts for titanium that go through 2015.

Additionally, some observers believe an increasing number of acquisitions of existing competitors are at least in part driven by the belief that the larger entity will have more clout to use in securing supplies or reducing prices for scarce materials.

No one expects a return to the completely integrated model of the past. Companies are not making these types of moves in areas where there exists a large and stable source of supply.

Nonetheless, supply chain managers in companies impacted by current or potential supply challenges would be well advised keep up to speed on current changes in perspective.

Do you think we will see a partial return to vertical integration, based on supply scarcity? How should a supply chain react to the current raw materials situation? Do you think this is a temporary or chronic situation? Let us know your thoughts.